Yvan Allaire's "The Case for and Against Activist Hedge Funds"

06/10/2015

Yvan Allaire's "The Case for and Against Activist Hedge Funds"

Yvan Allaire has posted a new analysis of hedge funds to SSRN:

A subset of so-called hedge funds, henceforth known as “activists”, has latched on the idea that many corporations are not managed or governed in a manner likely to maximize value for shareholders. With the capital they have obtained from pension funds and other institutional investors, they take a small position in the equity of publicly traded companies and push, with a varying degree of aggressiveness, for measures they deem likely to boost targeted companies’ stock price.

This is a fast growing business. The number of activist “interventions”, some 27 in 2000, has reached 345 in 2014 according to the WSJ-FactSet Activism Scorecard. Activist hedge funds have now amassed an estimated $200 billion in managed assets. To achieve more leverage on companies, smaller hedge funds may band in what has been aptly called “wolf packs”. In a by-now familiar scenario, the activist hedge fund calls on the targeted company to name to its board some people of its choosing (threatening a proxy fight if the company is not forthcoming). That is merely a first step, sometimes entirely skipped.

Unless the company swiftly gives in to its demands, the hedge fund will produce a paper, or a long letter, critical of the company’s management and board and outlining the remedial actions that, in its view, would benefit shareholders. That document will be broadcast widely so as to gather the support of the company’s institutional shareholders, even if a tacit one. In due course, if matters come to a proxy fight, the hedge fund will try to persuade the proxy advisors (ISS and Glass Lewis) to come out in favour of the hedge fund’s nominees for the board.

Allaire, Yvan, The Case for and Against Activist Hedge Funds (May 28, 2015). Available at SSRN: http://ssrn.com/abstract=2613154

Here's a key summary of his argument:

That some boards do not perform as well as expected may not be shattering news; the limited power of shareholders to get a reluctant board to act in a shareholder-friendly way has been well documented. However, recent developments in governance (majority election of board members, access to nomination process, elimination of staggered boards, say-on-pay, role of proxy advisors, etc.) have changed the relationship between boards and shareholders, giving the latter a lot more leverage over the former.

Nevertheless, one key argument of activists is valid; the current board governance practices in widely held corporations open the door to the activists. Boards are indeed too often dependent on management, and unable or unwilling to take the vigorous actions needed to create enduring wealth for the company.

That is indeed a problem calling for remedial action but not necessarily of the kind offered by activist hedge funds. Their sort of cure may be worse than the disease.

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Yvan Allaire has posted a new analysis of hedge funds to SSRN:

A subset of so-called hedge funds, henceforth known as “activists”, has latched on the idea that many corporations are not managed or governed in a manner likely to maximize value for shareholders. With the capital they have obtained from pension funds and other institutional investors, they take a small position in the equity of publicly traded companies and push, with a varying degree of aggressiveness, for measures they deem likely to boost targeted companies’ stock price.

This is a fast growing business. The number of activist “interventions”, some 27 in 2000, has reached 345 in 2014 according to the WSJ-FactSet Activism Scorecard. Activist hedge funds have now amassed an estimated $200 billion in managed assets. To achieve more leverage on companies, smaller hedge funds may band in what has been aptly called “wolf packs”. In a by-now familiar scenario, the activist hedge fund calls on the targeted company to name to its board some people of its choosing (threatening a proxy fight if the company is not forthcoming). That is merely a first step, sometimes entirely skipped.

Unless the company swiftly gives in to its demands, the hedge fund will produce a paper, or a long letter, critical of the company’s management and board and outlining the remedial actions that, in its view, would benefit shareholders. That document will be broadcast widely so as to gather the support of the company’s institutional shareholders, even if a tacit one. In due course, if matters come to a proxy fight, the hedge fund will try to persuade the proxy advisors (ISS and Glass Lewis) to come out in favour of the hedge fund’s nominees for the board.

Allaire, Yvan, The Case for and Against Activist Hedge Funds (May 28, 2015). Available at SSRN: http://ssrn.com/abstract=2613154

Here's a key summary of his argument:

That some boards do not perform as well as expected may not be shattering news; the limited power of shareholders to get a reluctant board to act in a shareholder-friendly way has been well documented. However, recent developments in governance (majority election of board members, access to nomination process, elimination of staggered boards, say-on-pay, role of proxy advisors, etc.) have changed the relationship between boards and shareholders, giving the latter a lot more leverage over the former.

Nevertheless, one key argument of activists is valid; the current board governance practices in widely held corporations open the door to the activists. Boards are indeed too often dependent on management, and unable or unwilling to take the vigorous actions needed to create enduring wealth for the company.

That is indeed a problem calling for remedial action but not necessarily of the kind offered by activist hedge funds. Their sort of cure may be worse than the disease.